A "TIC"ING TIME BOMB: RULE 506 MEETS SECTION 1031

Fordham Journal of Corporate & Financial Law, 2007 by Whitman, Elizabeth Ayres

All parties involved in the sale of the unregistered securities could be subject to an sec enforcement action or, in the case of a brokerdealer or registered representative, proceedings by the NASD.100 In addition, disgruntled investors could sue the sponsor for rescission of their purchases of the unregistered securities under section 11 of the 1933 Act.101 Further, although state securities commissions are preempted from regulating securities sold in compliance with Rule 506,102 if the Rule 506 exemption is lost, every state in which the securities are sold could bring an enforcement action for failure to have the securities qualified in that state.103

VI. SOLUTIONS TO THE TENSION BETWEEN THE REQUIREMENTS OF SECTION 1031 AND RULE 506

A. Developing Substantial Relationships before Sale of the Relinquished Property

In the current sale structure in which TICs are sold under Rule 506 by securities broker-dealers, the tension between the 45-day identification period for replacement property and the NTM 05-18 substantial pre-existing relationship requirement can only be resolved either by: (1) broker-dealers developing relationships with potential investors early, preferably before their relinquished properties are sold; or (2) broker-dealers finding potential investors through means that do not involve general solicitation or general advertising.

Although the requirements of a substantial pre-existing relationship and the prohibition of selling securities contemplated when that relationship is created creates tension in the TIC marketplace, these requirements also provide bright-line tests to assist broker-dealers and their registered representatives in determining which securities they can sell to which investors. In effect, NTM 05-18 and the no-action letters on which it is based, create a presumption that the general solicitation or general advertising was not in connection with the sale of a particular privately placed security if the security was not contemplated when the substantial relationship with the investor was formed.104 Therefore, it is key that broker-dealers develop relationships with investors well before they need to purchase replacement property.

B. When Broker-Dealers Can Engage in General Advertising

It is important to note that broker-dealers may engage in general solicitation or general advertising if that advertising is not in connection with the sale of privately-placed securities. TICA Best Practices states:

The following items . . . may be included in a general solicitation or advertisement:

* Discussion of the Internal Revenue Code

* Discussion of regulations and other tax authorities

* Discussion of TIC fractional ownership concepts that do not mention an offering or sponsor

* Reference materials that do not refer to a specific offering or sponsor

* Other items not specific to a particular offering or sponsor105

Broker-dealers, therefore, may advertise about TICs generally and the tax benefits of investing in TICs, as long as they do not sell to a person responding to that advertising any TIC that was contemplated when the broker-dealer formed a substantial relationship with that person.106 Broker-dealers also may conduct generally advertised educational seminars to which potential investors or attorneys, accountants, and real estate brokers assisting potential investors are invited.107 For such general advertising or general solicitation not to be construed as being in connection with the sale of a privately placed TIC, however, it must be focused on attracting persons who have not yet sold their relinquished property and who, therefore, do not yet have a need to purchase a TIC.